On your show Thursday, U.S. Senator Tom Coburn let the cat out of the bag on the shape of a possible “compromise” to balance the budget that includes an assault on the mortgage interest deduction on owner-occupied real estate.
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An industry that is fighting to get off the mat appears to be facing a sucker punch from the Administration and Congress with this new tax. The amazing thing is that it really isn’t going to hurt the “wealthy,” but it will devastate middle-class homeowners, the very people this Administration is supposedly trying to help. It makes no more sense now than it did several years ago when the assault on real estate began. Before I outline consequence of this proposed change, I want to compare what happened in the financial meltdown to a Texas Hold’em Game.
There were plenty of rules and regulations in the real estate financing industry that ought to have stopped the meltdown from happening, but the big players who ran the banks were making money without effort, so they weren’t interested in due diligence. Would you play poker with a group of strangers and not check the deck of cards to see if it was a proper deck? The banks had several ways to check the appraisals on the loans coming to them, from a desk top review to a field review to the ordering of a second appraisal. For the most part, they passed on doing any of it.
The banks weren’t concerned with the makeup of the loans in the pools they bought and sold. When they started falling apart from the handful of toxic loans within the pools, they were shocked and dismayed.
They could have checked every loan in every pool and the crisis could have been averted. But they didn’t do it.
This lack of discretion, and others, set off the meltdown and allowed the government to step into the void and the government wasted little time in directing the dismantling of that industry. Here are just a few of the changes that have left the industry teetering.
1. Andrew Cuomo’s idea to control appraisals through the Home Value Code of Conduct. This changed the way appraisals were ordered. Instead of the loan officer contacting the appraiser, now a processer or manager contacts a management firm, which then orders the appraisal from generally an out-of-the-area appraiser. The appraiser isn’t given any details of the transaction and only on a purchase would they know the price of the house, and therefore the value they needed to reach. The housing market suffered.
2. The government didn’t understand “quid pro quo” when they gave the TARP money to the banks to help them financially and give them an opportunity to make more home loans. The banks weren’t asked, and if they were, didn’t agree to use the TARP Funds primarily to make home loans. Instead, they invested in Treasuries and made a large amount of easy, and basically safe, investments that yielded large profits. Home loans were not on the top of their list of uses for the money. The housing market suffered.
3. Fannie Mae and Freddie Mac were taken over by the government and new rules were installed to prevent the problems of the past in the home finance industry. In my opinion, they entirely missed the boat and further harmed the fragile industry. In a move to stop the excesses of the past, which I believe began and ended with stated income for wage earners, they outlawed all stated income loans. This decision helped to create the foreclosure problem we are faced with today. People who called their lender to refinance to the new lower rates were told that without qualifying, they couldn’t help them…… unless of course, they missed three or more payments in a row. Ruin your credit and we will help you. The question of the day remained unanswered: “If I made my payments on time at a higher interest rate, why wouldn’t I be able to make my payments on time with a lower interest rate?” The housing market suffered.
4. Fannie and Freddie set new qualifying rules as follows: Tax returns must show sufficient income, loan-to-value ratios must not to exceed 95%, credit scores must be above 640, and the borrower needed some liquid reserves. These rules combined to greatly reduce the eligibility for loans of even good credit risks. The home market suffered.
5. Paperwork requirements were also changed to give “transparency” to the borrower. We now send out 37 pages of disclosures, most of which I am sure aren’t read, except for the Good Faith Estimate of Costs. This document scares and confuses 90% of the borrowers and the other 10% generally cancel the loan upon receiving it. A borrower can receive several of these “Good Faiths,” with each being different, so the confusion grows. When the loan is approved and ready to fund, the borrowers will have over 100 pages to read and sign. This now takes at least an hour, with the borrower actually less informed than before.
6. Fannie and Freddie are still losing money and the government felt the borrowers should help bring in more revenue. Thus the agencies increased the fees on all loans that amortize over 15 years, which includes adjustable rate mortgages. This will likely become a major problem under the new Regulation Z that comes out from the Federal Reserve on April 1st of this year. The problem with the new Reg Z is the inability of a loan officer to take a rebate from the lender and charge an origination fee. Although we won’t know the actual impacts of this new regulation until we start working under it, owners of rental property, holders of loans under $200,000 and those borrowers with lower credit scores could be facing an even more difficult lending environment than the extremely tough one that has governed the past two years.
And yes, the home market will suffer as a result.
Now I return to the latest uppercut to the industry, the proposed reduction of mortgage interest deduction and what that will do to home prices.
For years I had a poster in my office showing the Continental Congress in session. The caption was “Our forefathers did not come here to rent”.
This reduction of the home mortgage interest write-off, even if limited to loans above $500,000, will go a long way towards repudiating that caption. The mortgage interest deduction allows most people to pay all or part of their mortgage with before tax dollars, not after tax dollars. You earn the money, make the payment, deduct the interest and then figure your tax cost. After tax dollars means you earn the money, pay the tax and then pay the principal and interest out of the money that is left over. That is a huge difference. It means it will be much harder for people to qualify for loans, and it will harder for people who do qualify to do so for higher priced houses. The result will be weaker demand and falling home values –again. This will push people towards renting rather than owning. It will strike at what has traditionally been the best retirement investment in America, a paid-off home.
Last, but not least, I must reference the inevitability that once the government begins to cut the mortgage interest deduction, it will just keep doing so until it is gone completely. Wow!